Advances in Economics, Business and Management Research, volume 38 Trends of Technologies and Innovations in Economic and Social Studies (TTIESS 2017) Assessment of effects of property taxes imposed on small and medium enterprises in oblast

Galyautdinov Ildus Ilyasovich Institute of Economics, Management and Law, Irkutsk National Research Technical University Irkutsk, [email protected]

Abstract—The article describes the results of the three-year inclusive institutes because only those enterprises whose research on possible economic and social effects of the changes in property rights are protected will perform investment activities the Act of “On the property tax” on small and and increase labor productivity. Businessmen who believe that medium businesses of Irkutsk, , Bodaybo, Usolye- everything they earn will be stolen, expropriated or taxed Sibirskoe, , and . The article shows the heavily have no incentive to work, never mind investment and dependence of property tax rates and the number of small innovation activities. However, it is important to protect enterprises which will be forced to go out of business or to go property rights of both sides - the economic elite and general into a shadow economy. It was found that the maximum property public. tax rate of 2 % proposed by the Government of Irkutsk oblast will have negative effects on the regional economy, increase the Thus, one can argue that the statement about the fatality of number of the unemployed, decrease investment attractiveness the property tax of 2% in Irkutsk regional law has been taken and yield a reverse effect. Tax revenues of the regional budget into account. On the other hand, fears that the tax will be will decrease rather than increase. If the tax rate is 0,2%, tax imposed on all property items fallen within the purview of the effects will be less destructive, but can also have negative impacts. law irrespective of the property floor area have panned out Negative effects of the property tax depend on the floor area of earlier than expected. Since January 1, 2018, all property 2 properties. If the size is more than 5000 m , there will be no items having cadastral numbers will fall within the purview of negative effects. It is shown that initiators of the regional law the law irrespective of their floor area. A year earlier, only disregard existing tax and quasi-tax pressure on enterprises property items with a floor area of more than 1000 m2 were which puts the brakes on their development. taxable.

Keywords—taxes, property, small enterprises, business activity. During this short period until the beginning of 2018, it is necessary to determine the tax rate which, on the one hand, I. INTRODUCTION would contribute to regional and municipal budget replenishment and, on the other hand, would not do much In 2015, the author published the results of my research on harm to SMEs. possible economic and social effects of the changes in the Act of Irkutsk oblast on “On the property tax” on small and In [1], it was proved that the tax rate of 0.1% would force medium enterprises (SMEs) [1]. That article justified a thesis 5 percent of SMEs to go out of business. Those SMEs might statement about the fatality of the tax rate of 2 percent of the go out of business without adopting the law because of their cadastral property value for most SMEs owning facilities with sad state. The tax rate of 0.4 % would force 60 percent of a floor area of less than 1000 m2. SMEs to go out of business. The tax rate of 1.3% would force all SMEs to go out of business. This issue was being discussed by the general public involving regional lawmakers, government agents, Hence the question arises whether these calculations are representatives of noncommercial associations of businesses. relevant for the regional economy of the end of 2017. Is it It was being discussed by participants of scientific conferences possible to determine the tax rate which would solve a double held by Irkutsk National Research Technical University. In task in 2018 - ensuring budget replenishment and preventing November 2015, the debate was broadcasted live. As a result businesses from being shut down? The present article attempts of violent disputes, the law of Irkutsk oblast was adopted in its to answer these questions. first reading without increasing the tax rate which is still at issue. During public debates, representatives of Irkutsk Government put forward arguments for the maximum tax rate Public disputes are good news as they bear witness of of 2% arguing that it is not fatal for SMEs while their developing inclusive economic institutes in Russia. According reluctance to pay larger tax bills is only due to their greed. to some fundamental researches, inclusive economic institutes That approach (businesses should be hard controlled and their (as distinct from extractive ones) contribute to the economic complaints should be disregarded) is typical for Irkutsk region growth, increase labor productivity and prosperity [16]. and Russia as a whole. “Protected private property rights are a key element of the

Copyright © 2017, the Authors. Published by Atlantis Press. This is an open access article under the CC BY-NC license (http://creativecommons.org/licenses/by-nc/4.0/). 197 Advances in Economics, Business and Management Research, volume 38

The well-known extract taken from the work by a British and Administrative Offences Codes were adopted [3]. For four publisher and a labor leader Thomas Josef Dunning and cited and a half years, the volume of the Criminal Code increased by Carl Marx in his “Capital: Critique of political economy” by 28%, the volume of the Administrative Offences Code - by (Volume I. Chapter XXIV “The primary accumulation of 44%, the volume of the Criminal Procedure Code – by 9%. All capital”, Part 7 “The accumulation of capital”), is deeply these amendments are of incriminating nature. Humans are embedded into the thinking of some public officials: Capital is referred to as violators, offenders and thieves. said by Quarterly Reviewer to fly turbulence and strife, and to be timid, which is very true; but this is very incompletely People are afraid of starting business because there is a stating the question. Capital eschews no profit, or very small number of methods to initiate a criminal case against them. profit, just as Nature was formerly said to abhor a vacuum. Russia ranks third by the number of prisoners, tenth - by the With adequate profit, capital is very bold. A certain 10 per number of prisoners per 100 000 of the national population, cent will ensure its employment anywhere; 20 per cent will and second - among the largest countries. However it ranks 50th place by the human development index (education, certainly produce eagerness; 50 per cent - positive audacity; th 100 per cent will make it ready to trample on all human laws; medicine, welfare) [3] and 129 place by the life expectancy 300 per cent and there is neither a crime at which it will index followed by African nations [4]. In 2016, 200 000 criminal cases on economic crimes were being pended [14]. scruple, nor a risk it will not run, even in case its owner being hanged. If turbulence and strife will bring a profit, it will However, at the federal legislative level, one can observe freely encourage both. Smuggling and the slave-trade have some attempts to modify that oppressive situation. Public amply proved all that is here stated (T.J. Dunning, cit., pp. 35, officials began to understand that economic development of 36)”. Russia and growth in Russia’s citizens’ prosperity depend on In the Czarist-era, only a trading license is authorized to the level of business development. The Federal Act no 436-FZ carry out commercial activities. The Acts on Trading Taxes of December 19, 2016 amended Article 299 of the Criminal (1863-1865) and on State Business Tax (1898) prescribed the Code and Article 151 of the Criminal Procedure Code. The procedure of issuing trading documents. The entrepreneurs amendments are provided for severe punishment for themselves determined a guild and a category of their shops falsification of criminal cases against businessmen. and had a trading license of a certain guild. It is similar to the The Act aims at strengthening punishment for illegal uniform tax on imputed income (UTII) calculated and paid by criminal prosecution. It increased the maximum prison term businessmen depending on taxation objects. for that crime from five to seven years of imprisonment. The Did all entrepreneurs of the Czarist era pay their taxes in a same crime, associated with the accusation of a person of fair way? Unfortunately, they did not. According to the audit committing a grave crime or an especially grave crime, findings, in 1882 more than a quarter of commercial and is punishable by ten years of imprisonment. The same industrial institutions of Yenisei and Kansk districts carried punishment is provided for illegal criminal prosecution aimed out uncontrolled activities [10]. at stopping business activities from mercenary or other personal motives. The description uncontrolled can mean not only illegal. As an example, one can use the case of N.G. Gadalov, a Kansk According to the amendments in the Criminal Procedure entrepreneur. In 1888, he dealt with textiles, grocery and Code, investigation into the cases on the crimes stipulated in wholesaling. For wholesaling, he used a stone building Article 169 of the Criminal Code “Preventing from legal consisting of two rooms with two towers. In front of the business activities” was carried out by the Investigation building, there was a sheltered space where he kept barrels Committee of the Russian Federation. with sugar. The sheltered space provoked a conflict between Economic conflicts should be solved by using criminal the businessman and local authorities. According to the local procedures and illegal criminal prosecution against authorities, Gadalov underpaid taxes amounting to 787 rubles businessmen. – at that time it was a vast amount of money – due to incorrect gradation of the business. Government security officers are also used by businessmen who wants to deprive their colleagues of lucrative business The businessman paid the tax but appealed against the employing criminal methods. decision of the local authorities to the Ministry of Finance of Russia. The Ministry admitted that the shadow created by the In November 2016, the Plenum of the Supreme Court sheltered space is not real property and returned him 761 adopted Regulation No 48 “On criminal cases on business and rubles as illegally collected. However, 26 rubles were kept as other economic activities”. It was emphasized that it is a fine [11]. important to protect rights and property of those businessmen who are faithful in running business. Those ones who commit This historical retrospective illustrates constant conflicts crimes to eliminate competitors have to be prosecuted. between Russian businessmen and public authorities which are not always safe both for entrepreneurs and public officials. Criminal laws are getting more liberal. Recently, it has been adopted a new legislative act which makes it possible to substitute imprisonment for fines, but some regionals officials II. METHODOLOGY continue to consider entrepreneurs as heroes of the work by In 2012-2016, more than 200 laws on financial relations T.J. Dunning. between the Government and business amending the Criminal

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According to their viewpoints, entrepreneurs are greedy by The population of Irkutsk oblast is 21 400 million people. nature and do not wish to share their profits. The regional (14.6 percent of the total number of the Russian citizens). In government can maximize the property tax rate but what the first half of 2016, the monthly income was less than effects that increase will cause. Irrational increase in the tax 10 000 rubles. To be specific, in the second half of 2016, in rate can cause a situation similar to the one in Greece when Russia, the value of the minimum living wage per capita was seven years of the economic recession caused property prices 9 956 rubles per month, in the first quarter - 9776 rubles. collapse. Compared with 2009, real estate in Greece fell by 45% and is still getting cheaper. Due to increasing tax rates, The crisis increased the number of people living below the many owners attempt to dispose of their property, renounce national poverty line. In the first quarter of 2016, the number succession as heirs and even donate their houses and of such citizens increased to 22.7 million people. For apartments to the state. Greek real estate agents argue that comparison, in the fourth quarter of 2015, 14.4 million high tax rates harm the investment attractiveness of the local Russian citizens lived below the poverty line. real estate sector which was a key pillar of the national More than 1.5 million Russian people work abroad due to economy. As a result, in Greece, the supply exceeds the low level of salaries in Russia. demand: the number of real estate transactions reduced by 87%, and the data base contains more than 250 000 real estate Today, 20 percent of the poorest Russian people get only units. In Athens, Salonika and other large Greek cities, dozens 25 percent of financial resources allocated for the social of thousands of apartments are abandoned. The per square assistance. In the countries with a social support principle meter price fell to 300-400 euros, whereas in 2008, it implemented, that index exceeds 50 percent. amounted to 1000 euros. Being unable to sell their According to the data of the Russian Statistics Committee, apartments, the Greeks rent them at fire-sale prices. Numerous in 2016, food prices increased by 4.6 %, non-food prices - by ads for sale or to rent speak for the sorry state of the local real 6.5 %, service prices – by 4.9 %. In the EU, food prices estate market [12, 13]. It should be noted that that property is increased only by 0.5 % [14]. located in the Mediterranean, not in cold Siberia. Compared to the two previous crisis years, in 2016, price Crudity and undue haste of the regional authorities increase was not so significant. In 2015, for example, annual increasing property tax rates are typical for the history of inflation was set at 12.9 %, and in 2014 — at 11.4 %. But if Irkutsk oblast. For example, in there is a plot of land one takes into account that real income of the population has where a pulp and paper plant owned by Group Ilim is located. been decreasing for already two years, that price increase has The conflict resulted from the implementation of the cadastral negative effects on welfare of the Russian people. According value approach when calculating property taxes. The to the data of the Russian Statistics Committee, in 2016, real government of Irkutsk oblast increased the cadastral value incomes (average inflation-adjusted after-tax incomes) of the several times. The cadastral value for the plot of land owned Russian people decreased by 5.8 % compared to the same by Group Ilim in Bratsk was above seven billion rubles. period of the last year. The owner filed a dispute resolution request to equal the It should be taken into account that in 2015 and 2016, cadastral value of the plot of land with the market one (the law incomes of the Russian people decreased as well. The Institute entitles to it). The tax amount decreased 15-fold (452 million for Social Analysis and Prediction RANEPA calculated that rubles). Having challenged the decision in court, the municipal real incomes of the population decreased by 12.3% for two government won a suit. However the courts of appeals, years, real salaries - by 8.7%, and real pension rates – by 7%. including the Supreme Court, reversed that decision. According to the prediction of the Ministry of Economic As a result, the local budget did not manage to gain Development, by the end of 2017, the number of poor people additional income. Worse still, revenue from the property tax in Russia will have increased to 13.7% (from 13.1 % in 2015). sharply decreased by tens of millions of rubles. The peak poverty rate of 13.9% is expected to be in 2018. The regional government displayed such qualities as In the coming three years, due to the abolition of the incompetence, inability to calculate the risks of decisions indexation of pensions for working pensioners (at present, in made, unwillingness to apply scientifically grounded ideas Russia there are 30 million non-working and 10 million about social and economic aspects. working pensioners), pension rates will decline by 0.5%, What is the current social and economic situation? In the despite the fact that in 2017, the Russian authorities decided to first part of the present article, authors presented sad statistical adjust pensions according to the annual inflation rate. data on different aspects of the Russian economy as of In the first half of 2016, the volume of commercial December 2015. What changes happened since that time? services declined by 0.9 %, retail business - by 5.7 %, housing One in three employers is going to reduce employees and development - by 9.2 % compared to the same period of 2016. salaries. In the first half of 2016, the salary in retail business Real budget revenue has been constantly declining for (where most SMEs workers are employed) was 16 078 rubles, three years. The Ministry of Finance is going to reduce it by in the clothing manufacture (which is also negatively 15–20% within the next three years. Besides, a large influenced by the new law), the salary was 9 939 rubles, a budgetary gap exceeding 35% of the GDP, huge debts of the minimum living wage. Russian regions, serious bank crisis accompanied with annual bankruptcy of more than 100 banks, zero loan growth and

199 Advances in Economics, Business and Management Research, volume 38 significant reduction of investment loans, acute currency Heineken is not a poor company. Its profit before tax is 900 crisis, ruble devaluation, foreign currency inflow reduction, million rubles. capital drain are inherent features of the current Russia’s economy. Several years earlier, property tax exemption was granted to a Moscow Brewery Company SanInBev. Tax exemption GDP volume, investment, building, machine and did not work for the region’s economy as in 2014, the equipment production, retailing and commercial services are company closed down its branch in Angarsk. indices of incomes and consumption of the population which continue to decline deepening the country’s economic crisis. If It appears that the taxation policy of Irkutsk oblast aims at in the first half of 2016 the GDP rate decreased three-four-fold supporting the alcoholic beverage industry. Availability of compared to the same period of 2015, the investment rate, alcoholic products is not an issue for the population of Irkutsk building and retailing indices, real incomes, consumption oblast. According to the data of the Irkutsk Statistics index, education, health and social insurance funding, Committee, in 2015, 5 657 shops sold alcoholic products (in including pension rates, declined by 5 percent [15]. 2012 – 4 904), i.e. one shop per 330 residents. The total floor area of shops in Irkutsk oblast is 972 883 Salary debts are also increasing: as of January 2016, they 2 2 were 3.5 billion rubles, and as of December 2016 – 3.85 m2, of which 216 743 m – of food stores, and 756 140 m – of non-food stores. Shopping space availability is 1 623 m2 per billion rubles. In 2016, the number of criminal cases on salary 2 debts increased significantly (494 criminal cases against 505 1 000 residents (at the rate of 665 m ). In Irkutsk, there are accused). four retail markets, two hypermarkets, one small wholesale market, 93 supermarkets, 1 771 shops, and 1 563 non- According to the approach of the International Labor stationary shopping facilities (pavilions) of 4 421 shopping Organization, as of November 1, 2016, there were 4.1 million facilities of Irkutsk oblast. unemployed per 76.7 million economically active people (52% of the Russian population). It is five times as much as Imposition of the obligation to maintain the property on the number of the registered unemployed – 848 thousand SMEs not to speak of the property tax imposition is intolerable people [16]. burden and makes enterprises search for new non-core activities using the same facilities. Seven of ten SMEs engage For the first time since 2004, the number of liquidated in non-core commercial activities in order to prevent decline companies exceeded the number of created ones. According to in demand and profit and avoid bankruptcy. the data of the Russian Statistics Committee, from January to November 2016, 571 282 companies were dissolved, 381 144 The number of services provided by business centers is companies were created. Thus, the total number of companies increasing. Apart from renting out commercial facilities, hit a low: at the beginning of 2017, there were 4.5 million business centers rent out parking spaces, conference spaces, registered enterprises. As a comparison, in 2004, there were and provide clearing and logistics services. 4.4 million companies. In the food service industry, 43 percent of cafes and Thus, one can argue that the state of the Russia’s and restaurants conclude contracts for office catering, provide Irkutsk oblast’s economies did not undergo positive changes, lunch delivery services to tourist groups and building and the recession continues. companies. If this is true, from a crisis management perspective, the It ensures stable demand for catering services. Non-core increase in the property tax rate is incorrect. activities can bring 20 percent of the company’s income. Cafes and restaurants function as café-restaurants in the day- time and as café-bars at night. Customers are attracted by III. RESULTS broadcasting of sports events. In 2017, tax load growth will contribute to a further According to the data of the Irkutsk Statistics Committee, decrease in business activities and shadow economy growth. the number of optimistic entrepreneurs sharply declined. In As far as commercial enterprises go underground more often 2014, 22 percent of entrepreneurs described the economic than manufacturing ones, their numbers will significantly situation in the region as favorable. In 2015, that number decline giving way to low-quality grey imports. reduced to 14%, and in 2016 – to 4,5%. Amid the global production crisis, products quality The data show the direct dependence of the business deterioration and increase in counterfeit products are climate on deterioration of external economic factors and the unavoidable due to weak control of regulatory authorities and effective date of the law under study. The closer the effective high level of regulatory corruption rather than forced cost date is, the less optimistic the entrepreneurs are. saving. When calculating property tax rates, entrepreneurs used It should be noted that the government of Irkutsk oblast real market prices as the cadastral value of the property were can grant tax remission to any enterprise. For example, at the undercut by 10–20%. According to the calculations of the end of 2015, the government granted property tax exemption Ministries of Property Relations and Economic Development to Heineken Baikal Brewery. of Irkutsk oblast, the mean cadastral value of one square meter The tax amount was 10 million rubles which will not be in taxable shopping facilities was considerably lower – from transferred to the regional budget. What’s interesting, 14-16 thousand rubles (shopping centers Ruchei, Europark,

200 Advances in Economics, Business and Management Research, volume 38 etc.) to 23 thousand rubles per square meter (shopping centers Figure 1 shows that increase in the floor area boosts the Senator, Modny kvartal, etc.) in Irkutsk, 5.3-18 thousand probability of shut down for SMEs. For example, if the floor rubles per square meter in Angarsk (the mean value is 12-14 area of an office or a shopping center is more than 5 000 m2, thousand rubles), 14-17 thousand rubles per square meter in tax effects are neutralized. Sludyanka, and 11-12 thousand rubles per square meter in Chuna. For research purposes, the author assumed a tax rate exceeding the legaly provided maximum rate of 2% in order to For this very reason, tax rates calculated by premises determine if there are chances of survival for large businesses. owners and regional authorities differ significantly. Figure 1 shows that the tax rate exceeding 2% is critical Calculations made by the premises owners and author of even for large business. the present article are closer to the meaning of the legal concept of cadastral value. IV. DISCUSSION As a part of the research, the author conducted an opinion If the property tax rate is 2% of the cadastral value (initial poll among heads of the SMEs in Irkutsk, Angarsk, position of the government of Irkutsk oblast initiating a bill on Shelekhov, Usolye-Sibirskoe and Bodaybo to determine the the property tax), the share of that tax from the profit after tax maximum possible value of the property tax calculated by the under the simplified taxation system (STS) is 48.2-95.5%. It cadastral value which would allow SMEs to survive under is highly unlikely that an entrepreneur will run business under current economic conditions. It should be emphasized that the these circumstances unless he is not able to unlock his heads of the SMEs gave economically grounded statements business capacities in some other areas or regions. Combining rather than answers off the cuff. The poll results are shown in Figure 1. the results for commercial facilities with a floor area of above 1 000 m2 with earlier calculations for smaller facilities, one Figure 1 shows that if the tax rate is 0.1%, 5 percent of can identify a trend: for the facilities with a floor area of less SMEs owning reals estate with a floor area of less than 1000 than 1 000 m2, the tax rate of 2% is more fatal. The tax m2 will go out of business. It is possible that those SMEs will amount exceeds 100 percent of profit. The situation is due to go out of business irrespective of the tax rate due to their sad stiff competition in that market segment which is beneficial financial situation. It illustrates that the sector of small for the consumer as it decreases prices. In fact, the prices do business stands on the brink of the financial black hole. If the not decrease due to weak profitability of businesses caused by tax rate is 0.4 %, 60 percent of the SMEs will cease to exist. decreasing purchasing ability and increasing expenses on real If the tax rate is 1.3%, all the SMEs owning real estate taxable estate management. Increase in expenses results from rise in subject to the property tax stipulated in the Act on the property the prices of electricity, housing services, petrol, railroad rates. tax will cease existence. The prices continue to rise despite the economic crisis, against common sense and scientific recommendations. V. CONCLUSION The calculations show that whatever be the increase in the tax rate in Irkutsk oblast, things for the SMEs owning real estate with a floor area of less than 1000 m2 (more than 90% of SMEs) will get worse. Nevertheless, the law has been adopted. The way out is to introduce a tax rate of less than 0.2%. The owners of large shops and offices, which pay taxes under the STS, will enjoy significant fiscal loosening, but it will correspond to scientifically ground anti-crisis management. The tax rate of 0.2% will not be shock for all SMEs. Increase in the tax rate will force 15 percent of SMEs (real estate owners and real estate tenants) to go out of business and others – to adapt for additional burden.

Fig. 1. Dependence of the number of enterprises forced to shut down their In general, adoption of the Act on the property tax will not business activities on the property tax rate improve the business climate for small and medium businesses. In 2019, it will decrease the number of SMEs, Axis of abscissa – the tax rate from 0 to 3.0%. increase the number of the unemployed and cause shadow Axis of ordinates – the number of SMEs in Irkutsk oblast; economy growth. the number of SMEs as on January 1, 2017 is taken as 100%.

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